An ‘Austrian’ defense of the tort system

Sasha Volokh has a thoughtful and well-reasoned post in which he confronts Ben Stein about the notion that tort lawsuits somehow represent an intrusion of “big government” into the otherwise pristine workings of the market system. No, says Sasha, the tort system is a way to force economic actors to take into account the risks their actions impose on others, just as they should. Compared to explicit regulation, tort suits are both decentralized and relatively immune to some of the rent-seeking that goes on in the legislative and administrative processes. Thus, from a libertarian perspective, the common-law tort system is actually the preferred means of regulation.

All of that seems right, though I’d offer a modification to Sasha’s argument. He says that ideally an entrepreneur would get all the benefits and pay all the costs of his innovation, and argues that tort damages are part of “all the costs.” But — putting aside the external-benefit point, which Sasha makes — the only entrepreneur who gets all the benefits of his innovation is the hypothetical price-discriminating monopolist. In the more usual case, there are consumers’ surpluses. (Being forbidden to buy a vaccine at the market price would leave the consumer worse off.)

So if we stick manufacturers with all the costs, but can’t secure for them all the benefits, then the overall level of market activity will be suboptimally low. Tax-induced and other “wedges” just make this worse.

That suggests second-order policies to deal with the distortions caused by first-order policies, which was exactly Hayek’s fear: that each intervention becomes a justification for the next. Not being a libertarian, I don’t regard that as a problem, but I agree that it’s a fact.

From a non-libertarian perspective, I’d think about the tort-liability problem somewhat differently. Market-based activity sometimes creates risks of large, stochastically-distributed losses. The expected value of those risks ought to be thought of as a cost of the activity, and the market will not function properly unless the party which generates the risk is forced to pay the cost. In addition, those who are at risk of suffering large losses have a reason to want to spead that risk around (risk aversion due to the diminishing marginal utility of income). Sometimes private insurance can accomplish that risk-spreading, but often private insurance markets fail due to adverse selection and moral hazard.

So we need a system both to limit risk-imposing actions and to compensate large-volume losers from such actions. Tort litigation competes with regulation plus social insurance as a way to serve those two purposes. Which system, or combination, is best will vary from circumstance to circumstance. The people who praise Europe for not having an American tort system also criticize it for having lots of regulation and generous social insurance. But the two sets of choices aren’t independent. You pays your money, and you takes your choice.

UPDATE

Sasha responds, and corrects my imperfect statement of his position. His bottom line is precisely mine, about this and most other policy choices:

As it happens, what we have to choose between in reality is the imperfect tort system and an imperfect regulatory system.